MFs tempt big investors with assured returns

Check your facts for the right fund MUMBAI: Pushed to the wall, several mutual fund (MF) houses have cut off-market deals with corporates and financial institutions to fight the cash crunch.

With redemption pressures mounting amid a liquidity squeeze, some fund houses have given "guaranteed" returns to big-ticket investors who were willing to bail them out by parking money in MF schemes for a few weeks. Under the arrangement, even if the net asset value (NAV) of the scheme dipped, these investors would be allowed to exit at a higher, pre-agreed NAV — something that other investors in the scheme would be clueless about.

This is just a variant of a mutual fund industry practice, where big investors are given cash incentives upfront to invest, as fund houses try to outwit each other in the numbers game. However, this time, the 'extra' return is handed over to the investor at the point of exit; and the intention is not to grow the fund's assets under management, but to avert a serious crisis, or even a default.

As inflows dried up and the prices of securities plunged, several MFs found it difficult to meet redemptions, with investors pulling out money from fixed maturity and liquid funds. The deal with corporates was a sharp practice in desperate times.

This is how it works: say, the NAV of a scheme is Rs 10.10 when the corporate invests in it; the deal is that the money will lie with the fund for a fortnight, after which the corporate will exit at an NAV of 10.25. Even if the NAV slips to 10.05 after a fortnight, the investor still gets out at 10.25. The fund finds a way to pay this extra 20 paise (per unit) to the investor.

"Either the asset management company pays the extra return, or it can be shown as marketing expenses... However, some funds have charged this as expense in an existing scheme, where expenses can be amortised over the life of the scheme. It's virtually impossible for investors and even auditors to get wind of this," said an industry source familiar with such transactions.

The extra return could be handed over as an incentive to MF distributors who pass it on to clients. "At times, the investor collects the extra guaranteed money through a separate cheque, which is credited to the account of one of its investment subsidiaries. So, in its book, the investor may show that it has exited at the market NAV (i.e., Rs 10.05) just like any other retail investor, while he collects the extra money in a group subsidiary," said a senior distributor.

There are fears that more fund houses will have to resort to such transactions if redemption pressures continue. Last week, the Reserve Bank of India used every monetary policy tool in the book to flood the market with liquidity. A slice of it may eventually trickle down to mutual funds. But it won't be instant or easy.